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With a population of 1.2 billion and a vast emerging middle class, India is nirvana for manufacturers of everything from motorcycles to shampoo. But for some of America's biggest mutual-fund companies, India has been a miserable disappointment, causing Fidelity International to exit the country last month and reportedly pitting T. Rowe Price against regulators.

The landscape of the mutual-fund industry in India is fascinating, and the challenges facing fund firms aren't small. Sudden regulatory changes have frustrated efforts to gather assets; there's stiff competition from local players; retail investors have been slow to adopt mutual funds; and India's stock market performed worse than any other in Asia last year. These issues have combined over the past three years to sound a death knell for the industry, says Don Putnam, managing partner of Grail Partners, an investment bank that specializes in the asset-management industry.

Since 2010, assets in Indian mutual funds have been at a near standstill, with just $130 billion in assets, mostly in fixed income, according to BlackRock. That's just 1% of the $13 trillion in U.S. mutual funds, for a population three times larger. But that big growth opportunity has turned into a big headache.

For years, India's erratic regulatory process has frustrated U.S. fund companies that are used to a much slower and more participatory regulatory environment. For instance, overnight and without warning (just try that stateside), the Securities and Exchange Board of India (SEBI) decided in August 2009 to ban upfront sales loads. Those sales loads had been as high as 6% and were paid by the investor but used to compensate the nation's largest banks, which are the primary distributors of mutual funds. Without that incentive, banks have since been directing more money into their own mutual funds, says Ashu Suyash, country head of FIL Fund Management, which Fidelity launched in 2004.

India's New Pension Scheme, partly modeled on 401(k) plans, hasn't helped, either. It offered no incentive for mutual-fund managers to participate, offering them an incredibly low management fee of 0.0009% of assets. And mutual funds are still not allowed to manage insurance assets.

Most recently, Fidelity struggled with a rule that forbids advertising of offshore funds, even though individuals are allowed to invest up to $200,000 overseas annually. With no way of making Indians aware of its offerings in Boston or London, Fidelity's strategy to use its Mumbai office to cross-sell products was stillborn. "They operate a global model in every market, and India is a very domestic market," says Suyash. Fidelity agreed in March to sell its local company to Mumbai's L&T Finance Holdings.

T. Rowe Price, meanwhile, is quietly chafing against regulatory interference in choosing a local CEO. T. Rowe owns a substantial stake in Unit Trust of India Asset Management, whose chairman quit in February 2011 to become head of SEBI. The Finance Ministry reportedly rejected a candidate favored by T. Rowe, and the company remains leaderless. A spokesman for T. Rowe declined to comment, apart from saying India is "a significant opportunity for the long term."